Saturday, April 23, 2011

Our pot of gold for when the mines run dry

Clancy Yeates looks at how a sovereign wealth fund might take shape.

Norway's got one, so does Chile. For decades, the oil-rich Gulf states have also squirrelled away their export revenue into a public savings pool, known as a sovereign wealth fund.

Now, there are growing calls for Australia to develop a fund of its own to make the most of the resources bonanza.

Backing from the likes of Commonwealth Bank chief Ralph Norris and Liberal MP Malcolm Turnbull has increased pressure to save more of the boom.


For the most part though, debate has skirted around just how this might work in practice. For a government battling to convince the public of the need for a carbon tax, a savings fund probably falls in the too-hard basket.

This need not be the case. Commentary from a growing number of economists, business people and former officials suggests a fund is not only sensible for Australia, but doable.

So if we did choose to go down this path, what might an Australian sovereign fund look like?

As debate heats up over whether we should have a fund, overseas experience can shed valuable light on the role such a fund would play here.

Sovereign wealth funds have enjoyed a meteoric rise, shrugging off the global financial crisis on the back of soaring commodity prices.

The value of assets held by these government-controlled monoliths leapt 11 per cent to $US4.2 trillion last year - almost double all private equity holdings. The sector's value is tipped to hit $US5.5 trillion next year and $US10 trillion by 2015.

Among the countries that have gone down this path there is a recurring theme - commodity wealth. From the $US38.6 billion Kazakhstan National Fund to the $US627 billion Abu Dhabi Investment Authority, the trend was led by oil-rich states from the 1950s.

Resource-poor countries such as Singapore and South Korea have also used sovereign funds to pool public pensions or save their foreign exchange reserves. But it is the commodity-rich states that are most relevant to Australia.

According to the International Monetary Fund, almost all of the sovereign funds established by commodity-rich countries have one of two objectives: saving the windfall from a boom or smoothing the bumpy ride of commodity cycles.

Australia's Future Fund is a public servants' pension fund that neither smooths the boom and bust cycle nor saves for the nation, and many economists say this is a big gap in our policy settings.

The former Reserve Bank governor and superannuation chief Bernie Fraser says we should be storing away the valuable ''nuts'' of the boom.

''We're just floating by on the commodity boom, giving most of the proceeds back to the mining companies, which are not going to provide the kind of social and economic infrastructure that will sustain this country over the next 30 to 40 years,'' he says.

''I despair about what happened with the resource rent tax - that should have been the big nut that was put away and used down the track when the mines are gone and we're looking for some way of maintaining activity and infrastructure.''

When the boom inevitably comes to a halt, Fraser says a fund could offset some of the pain by having ''social and infrastructure projects developed, on the shelf, ready to go''.

For others, stability should be a key objective of an Australian fund. Mining investment as a share of gross domestic product is already approaching 5 per cent - well above levels reached in the 1960s and 1970s - leaving us more exposed to a sudden slowdown in world demand.

Chile's $US22 billion stabilisation fund receives budget surpluses of more than 1 per cent of GDP. When commodities tanked during the global financial crisis, an injection of $US4 billion from the fund helped limit the worst of the recession.

The Grattan Institute economist Saul Eslake argues that Australia should adopt a fund to accumulate large budget surpluses, as the task can't be left to politicians.

Both the Howard and Rudd governments struggled to justify surpluses of more than 1 per cent of GDP, he says, so they gave the wealth back as unnecessary tax cuts. The budget is forecast to reach a surplus of 1 per cent of GDP by about 2016, he says, and Labor would probably follow the same approach.

''That would be no more appropriate than it was when Howard and Costello and Rudd and Swan did it. It would put upward pressure on inflation and interest rates,'' says Eslake, who has been arguing for a fund since 2005.

Besides economists, many non-resource businesses are also keen on a fund to shield them from the ''resources curse'' - a hollowing out in other parts of the economy as mining expands its share.

The Australian Industry Group, for instance, is investigating whether a fund can help protect manufacturing exporters from the higher dollar, which erodes export earnings. The group's public policy director, Peter Burn, points to Norway's fund, which has a mandate to buy overseas assets with oil revenue, in a bid to dampen the effect of a soaring exchange rate.

''A sovereign wealth fund financed from the boost in revenue at times of high commodity prices would assist in stabilising the macro economy and, if the fund purchased offshore assets, could also dampen the exchange rate impacts of booming commodity prices,'' Burn says.

Leading executives have weighed in to the debate. Chief executives from the Commonwealth Bank, ANZ, Tabcorp, Foster's, CSL and Coca-Cola Amatil and Orica and chairmen from Mirvac, Gloucester Coal and Pacific Brands have also backed a fund with the objective of saving or stabilisation.

The idea is also grabbing attention in Canberra, after the opposition communications spokesman, Malcolm Turnbull, backed calls for a national fund. He thought the stabilisation goal of Chile's fund was probably appropriate, but the fund could also earmark funds for ''very long term savings''.

''All of us know the value of savings targets, whether it is a child's money box or a family's super funds,'' he said in a speech this month. ''A national savings fund of this kind would become a matter of real national pride, evidence that we have the discipline and vision to recognise that good times don't last forever, that demographic changes will place greater demands on future budgets and that thrift is both virtuous and prudent.''

Support for a fund is not universal - the former Treasury secretary Ken Henry last year said greater saving and smoothing the boom-bust cycle could be achieved ''within the overall budget strategy''. Free-market think-tanks such as the Institute for Public Affairs say the government should return commodity wealth to the people through lower taxes.

But supporters of a fund appear to outnumber the strident opponents.

The governor of the Reserve Bank, Glenn Stevens, has raised the prospect of a ''stabilisation fund'' without supporting the idea, and the Treasurer, Wayne Swan, has not ruled it out.

''If we were in the position of not only coming back to surplus but coming back to a position where we had no debt, then maybe that would be an option,'' Swan said in December.

Despite growing support for a fund, public debate has largely steered clear of how one might be designed.

What type of assets would it hold? How and when would it spend the money? And how to make sure politicians did not raid it, leaving the cupboard bare.

Treasury documents released under freedom of information suggest the government is luke-warm on a Norway-style fund, which invests its $US450 billion overseas.

A previously secret briefing from last year highlighted Australia's different circumstances, saying: ''Norway has a single finite resource in its interest in North Sea oil. Australia has more diversified and longer-lived resources. So it doesn't necessarily follow that what is appropriate for Norway should … be followed in Australia.''

Private sector economists agree an Australian fund would have less need to hold all of the assets overseas, as the potential damage from price swings is less here than in Norway. However, a fund could not avoid being a big investor overseas.

''Australia is a very small part of the global market, so inevitably investing overseas is going to be a very important part of the strategy,'' says Gordon Clark, an Oxford University professor who specialises in sovereign wealth funds.

''In designing these institutions you have to be very conscious that, given the volume of assets, you don't overwhelm domestic financial markets.''

Whether a fund should try to restrain the surging dollar to help certain industries is contentious.

A former deputy governor of the Reserve Bank, Stephen Grenville, has cited sovereign wealth funds as one way of addressing the hollowing out of manufacturing caused by the dollar. He has argued that if this is the goal the investments would have to be in foreign assets.

The Australian Industry Group has also found that Norway's manufacturers have fared better than others in Europe.

But the HSBC chief Paul Bloxham says suggestions we follow Norway by trying to ''ring-fence'' commodity earnings are ''radical''.

''We floated the exchange rate in 1983 and we have gradually gotten used to the idea that the Australian dollar is freely floating and quite volatile,'' says Bloxham, who supports a fund. ''If you put it outside the rest of the economy the exchange rate would start to operate in a very different way.''

Fraser also warns against trying to manipulate or manage currencies through a fund. ''The magnitude of any sovereign wealth fund are peanuts to the volumes of money that float around on the foreign exchanges,'' he says.

Wherever its assets were held, an Australian fund would be under pressure to adopt a conservative investment strategy, after key sovereign funds suffered heavily in the global financial crisis.

Singapore's Temasek fund and Norway's long-term savings funds - both of which invest heavily in shares - lost more than 20 per cent in 2008. The shorter-term stabilisation funds of Chile and East Timor, which hold mostly bonds, held up positive returns throughout the financial crisis.

How the money might be spent is also up for debate, but an early favourite is on infrastructure.

ANZ's boss, Mike Smith, echoed the thoughts of many economists when he said funnelling earnings into the nation's creaking infrastructure would be a ''sensible idea''.

The Grattan Institute's Eslake adds that a fund could support spending on social infrastructure that politicians tend to ignore, such as aged care or indigenous affairs. Strict rules would be needed to ensure the money was spent at the right time. ''You structure it so that the government can access the income produced by this fund but not the capital until such time as when the mining boom is over,'' he says.

Turnbull also concedes politicians have a ''very strong temptation to splash money around'' - often with tax cuts at the peak of the boom when they are needed least.

There would also need to be a healthy degree of separation between the fund and the elected government.

According to Oxford's Professor Clark, the worst performers tend to be those governed by people too close to their political masters.

''You can't have these entities subject to the flux and flow of federal elections. That's going to be very, very damaging to any sovereign wealth fund's capacity to invest for the long term.''

In a sector that is notorious for being opaque, most agree the Future Fund has has set the bar high for independence under the outgoing chairman and frequent government critic, David Murray.

Shielding Australia from the commodity bust and boom cycle is a worthy goal - most agree on that. Saving for future generations also has wide support. Interest rates and budgets will probably remain the main policy ''levers'', but there is support for some sort of fund.

After observing other countries' experiences, a key lesson seems to be that Australia's situation is distinct, given the wide range and long lifespans of our resources.

Eslake says this means we should be flexible in designing a fund.

''Although our circumstances are in some ways similar to Chile and Norway, the fund itself [may need to be more] like the Chinese one,'' referring to the $US300 billion China Investment Corp, which has a wide-ranging portfolio of bonds, shares, and strategic stakes.

For all the interest in a sovereign wealth fund from business leaders, however, they have artfully ignored the elephant in the room.

As Bernie Fraser points out, a government is unlikely to embark on this path until it is confident it can extract more tax from a booming economy, and last year's mining tax brawl showed just how hard this is.

''You can't really talk about company tax reductions and sovereign wealth funds in the same breath. It's not going to happen if that's the sort of philosophy or ideology that's driving the debate,'' Fraser says.

Source: http://www.smh.com.au

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